Thursday, December 30, 2010

When is QE not QE?

The most recent Fed balance sheet data are summarized here. Note where the Fed was yesterday (12/29/10) relative to a year ago (12/30/09). On the asset side, "securities held outright" has increased by about $300 billion, with an increase of about $230 billion in long-maturity Treasuries, and a net increase of about $70 billion in agency securities and mortgage-backed securities. However, on the liability side, the increase in outside money has been quite small, at about $15 billion ($54 billion increase in currency, $39 billion decrease in reserves). As I remarked here, what is going on with Treasury reserve accounts at the Fed is important. During the year, the balance in the Treasury's general account dropped by $31 billion, but the Treasury also accumulated $188 billion in its "supplementary financing account." This supplementary account was created in September of 2008, and is described here. Basically, the Treasury sells T-bills, in exchange for reserves, and deposits the proceeds in this supplementary account. The balance in this account peaked at about $560 billion in November 2008, went to zero for a period late in 2009, and rose to about $200 billion in April 2010, staying constant at that level since. The Fed thinks of this as a reserve-draining operation.

Thus, once we take account of accumulation of reserve balances by the Treasury, and reductions in lending by the Fed, total outside money has increased little in the past year, in spite of a net accumulation of $300 billion in securities. Indeed, if we take the Fed seriously that it wants to "quantitatively ease," it is not doing it, since the total quantity of Federal Reserve liabilities in the hands of the private sector declined in real terms during 2010.

9 comments:

I understand you want to draw a big distinction between "reserves" and "currency" on one side, and T-Bills/Treasuries on the other. Unfortunately,this distinction is completely artificial. There is no distinction other than the yields (0% for currency, FFR for excess reserves, and term structure for T-Bills/Treasuries). The operationnal reality is that treasuries in circulation as a result of the "supplementary financing account" are just private accounts at the U.S. Treasury... just likes excess reserves are private bank accounts at the Fed (you want to open an account at the Treasury? Go ahead: http://www.treasurydirect.gov/tdhome.htm ). If you want to call reserves or currency "outside money", fine with me. There is no basis however for excluding T-Bills/Treasuries from this definition.

Yes, good point. What matters is the outstanding liabilities of the consolidated government - currency, reserves held by private financial institutions (I guess we're including Fannie and Freddie here), and Treasury securities in private hands. If the Treasury issues T-bills and deposits the proceeds from the sale in a reserve account with the Fed, this will essentially not matter, to the extent that T-bills and reserves are roughly identical assets. What makes reserves different is that they can be converted one-for-one into currency, which is clearly different from T-bills, in that it can be used in retail transactions. Now, suppose that the Treasury dropped the supplementary account balance to zero (say, when the T-bills mature), so that privately-held reserves rise by $200 billion. Will any of that $200 billion end up as currency? It's not clear why it would, but the Fed does seem to think that they can get some more inflation out of QE2, in part by flooding the system with reserves. If the Fed people are right, then the positive balance in the supplemental account works against what they are doing. At best it's neutral, but then why is the Treasury holding $200 billion in the account?

An increase in outside money is neither necessary nor sufficient for an increase in M1, M2, or MzM. The idea that the effects of monetary policy can be summarized by the effects on some monetary aggregate is of course an Old Monetarist idea. There are many ways in which Old Monetarism is not very useful, and this is one of them.

So you don't believe in the money multiplier? Interesting. When did this split between old and new monetarism occur?

I also agree with your recent comment about the Treasury's general account. The rise is a bit baffling. Is the Fed paying lip service to QE2 and secretly sterilizing behind the scenes? Will be interesting to see if the general account is drawn down in January or not.

When Treasury announced a resumption of TSF funding (in early 2010), some speculated that this was a backdoor way of taking back/sterilizing some of QE1. The economy appeared to be strengthening then, and the Fed was about to raise the discount rate, all of which gave credence to this explanation.

When the economy weakened in the summer of 2010, QE2 became a possibility and it made no sense to sterilize part of QE1. However, it also became clear that the GOP might take back the House in the midterm elections, making the debt ceiling a political issue for early 2011. Thus, by keeping funds parked at the Fed, Treasury has a store of cash available to pay interest on Treasuries should Congress fail to raise the debt limit. This might reassure the Treasury markets in the event of a government spending "shutdown".

Just speculation, of course, but, incredibly, we have little actual information to go on when explaining why the federal government is parking close to $200b at the Fed.

Very good. Of course in parking $200b a the Fed, the Treasury had to issue debt, which shortens the time unitl the limit is exceeded. But this seems as good an explanation as any for what is going on. As you point out, the Fed is silent about this. They presumably don't want to draw attention to anything that would make you want to question their independence.

You write, "Indeed, if we take the Fed seriously that it wants to 'quantitatively ease,' it is not doing it, since the total quantity of Federal Reserve liabilities in the hands of the private sector declined in real terms during 2010." The Fed itself never proclaimed a policy of "quantitative easing." Indeed, Chairman Bernanke repeatedly has emphasized the different perspective of Large Scale Asset Purchases, indicating that it isn't about the expansion of Fed liabilities but about influencing the prices of assets by removing certain types of securities from the market.